Fundamentals finally influencing cotton prices

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Fundamentals are starting to exert some influence on cotton prices again, according to cotton market analysts speaking at the Ag Market Network’s December teleconference.

In mid-December, old crop futures prices surged into the mid-70s, while on Dec. 14, December 2010 cotton closed at a little over 77 cents.

According to Jarral Neeper, president of Calcot, “USDA continues to provide the market with very supportive numbers, which gives much credence to the current price level. Since May 2009, USDA has reduced (old crop) world production by 4 million bales, increased world consumption by a million bales and reduced world ending stocks by 6 million bales, which are now at their lowest levels since 2003.

“World production is now projected at 103 million bales and world consumption at almost 115 million bales. The resulting deficit would be the largest in modern history, slightly surpassing that of 1980. If accurate, the foreign production-consumption deficit of 21 million bales would be the largest in history.”

As a result, “prices have rallied furiously since the beginning of this crop year, from a low of 54.97 on the nearby contract in August to the most recent high of 76.13 on the nearby. Whether we can move higher from here is on everyone’s mind,” Neeper said.

China is the principle reason for the foreign production-consumption deficit, according to Neeper, accounting for 15 million of the 21-million bale deficit in projected consumption. “Internal Chinese prices are trading at a dollar a pound, plus or minus a few cents. One has to wonder if the reality is something much more substantial.”

Neeper noted that the Chinese government has been auctioning off 12 million bales of cotton it purchased in 2008 to support internal prices and encourage plantings for 2009. Today, about a million bales are left.

“In addition, Chinese cotton imports have totaled 1.5 million bales between August and October.”

In spite of the imports and auctions, cotton prices have continued to rise, Neeper said. “On Dec. 8, China announced that it would distribute WTO-mandated quotas of 8.7 million bales, presumably prior to the end of 2009, with plans to issue another 4.6 million bales in April 2010, for a total of up to 13.3 million bales of import quotas.

“Part of the problem is that the Chinese crop harvest has been delayed due to weather. And believe it or not, there are speculators in China holding onto cotton in anticipation of even higher prices.”

One problem is that the average qualities of Chinese cotton are less than a year ago. “It’s entirely likely that the Chinese price appreciation is over, or very close to it. As such, it’s unlikely that U.S. futures prices have much further to go on the upside in the short-term.”

One reason for this is the uncompetitive price level of U.S. cotton, according to Neeper. “A year ago, between August and October, the United States had an import share in China of almost 60 percent. This year, it’s 38 percent. India, Australia and West Africa have replaced the United States for now.

“Moreover, total U.S. sales commitments of Upland cotton are the lowest since 2000 for this time of year, which was the last time we exported less than 10 million bales.”

USDA currently estimates U.S. exports at 11 million bales, based on the calculated needs of the Chinese. “So we have to wait until India and other countries run out of exportable supplies. How long we wait is difficult to know right now.

“It would be easy to think that New York futures need to retreat by some meaningful amount,” Neeper said. “But I don’t think that’s going to happen in the near-term. First of all, there is too much cotton sold on call that needs to be priced by mills. The March contract alone has roughly 2 million bales of unfixed cotton.”

Neeper says there is good demand for U.S. cotton “should we fall to the 68-72 cent range. Plus we’re approaching a new calendar year which should bring some adjustments by the hedge and index funds in the percentage of cotton owned versus the other commodities. I believe it will bring a net increase of buying into the market.”

The bottom line is that New York futures are about as fairly valued as they can be, according to Neeper, “which explains the narrow range of trading lately. And we’re entering the traditional holiday time frame when a natural decline in trading volume is more common.”

Further out, Neeper sees the potential for the March contract of 76-79 cents. “We hit that yesterday (Dec. 15) and it could go further. For the next several weeks, March is caught between a low of 68 cents on the downside and 79 cents on the upside, and more than likely we’ll be mired in a much narrower trading range.”

Supplies will be tight for new crop cotton, too Neeper says. “No doubt the job of the market this coming spring will be to pull acres and bales back into the system. If we don’t, things will get tighter.”

USDA projects a 9 percent increase in world cotton plantings in 2010 which would produce between 110 million and 112 million bales. With usage projected at 114.4 million bales or higher, ending stocks would continue to decline.

“If consumption this year or next is considerably better than projections, no doubt we’re going to have to see higher prices this spring.”